Earnings season is once again upon us, with Infosys beginning the cycle of announcements on 13 July of results for the quarter ended June 2018.
There are a couple of factors that will impact information technology (IT) services firms this earnings season and will be common across all scrips. One factor is a rebound in overall market activity in the large deals space. The second is swings in currency valuations, as the US dollar strengthens and other macroeconomic factors begin to play a role across the world’s currency markets.
Let’s first look at the large deals space. Earlier this year, I had written about specific findings that Michael Connors, the CEO of market research and consulting firm Information Services Group (ISG) had shared with me for this column. It appears that ISG was right. To recap, ISG said at the time that mega contract durations have shrunk and had arrived at a record low of 3.2 years last year. This means that deals activity in the market for old contracts coming up for renewal would be quite high through the rest of this calendar year—and that Indian firms, along with their competition from outside India, will benefit secularly from this activity.
According to ISG, large deals that have an annual contract value (ACV) of $40 million plus have remained in a fairly tight range. Over the last few years, the market has generated between 100 and 120 deals, with an ACV of more than $40 million.
When we spoke for this column, Connors also offered a few more observations:
Eight of the past nine quarters have exceeded $9 billion in ACV. The economy seems to be improving worldwide.
Disruption by “digital" competition is pushing a switch from traditional products to new technology.
The shift to as-a-service contracts (instead of traditional, full-time equivalent and billing hours-based contracts) continues to push the market higher.
Meanwhile, traditional sourcing has not let up; its ACV actually rose slightly compared to that of last year. This continued spend indicates that as-a-service is not replacing the traditional sourcing business. The pie is growing, rather than getting reallocated.
The second factor is the swing in currencies over the past few months. The sudden, sharp fall in the rupee vis-à-vis the US dollar will no doubt aid the earnings numbers from each of the Indian majors. However, given that many of these firms now also derive significant revenues from outside the US, some of this impact is likely to be tempered by cross-currency swings as well.
Along with the rupee, the euro, the British pound and the Australian dollar have also all fallen vis-à-vis the dollar, meaning that revenues from those countries would have been negatively impacted.
While the positive impacts of these two overall factors are clear, they will impact IT services firms differently, since each has had firm-specific factors affecting their current performance. Equity analysts expect most Indian majors to report their results in a range that straddles a 3% quarter-on-quarter drop and a 2.5% quarter-on-quarter gain in dollar terms. That said, the expectations are in line with what each firm has guided the market on, and analysts expect most firms will have sanguine predictions on growth for the rest of the year.
IT services bellwether Accenture seems to be the firm that most equity analysts have now taken as a yardstick against which other firms are measured. That firm has reported strong results for the past quarter, with revenue growth outstripping the top end of estimates, and particularly strong growth in the US market. Accenture has also started to corral the catch-all definition of “digital" and now defines it as “Interactive, Applied Intelligence, and Industry 4.0".
In my opinion, while Indian IT services firms will have a couple of quarters of excellent numbers, they are not quite out of the woods yet. They have not yet completed their turn into the “digital" world and cannot solely base their strategy on bagging renewal contracts and banking on a falling rupee.
Take another look at your investment horizons. If they are short, stay invested in Indian IT. If they are long, begin to pare down.
Siddharth Pai is founder of Siana Capital, a venture fund management company focused on deep science and tech in India.